RBA on Australian banking – Solid as a rock!

The RBA released its Financial Stability review yesterday which was its usual comprehensive document.

Here is very high level summary of what they said with regard to the domestic sector:

The Australian Banking system is in fine fettle.

The RBA, like APRA are worried about the credit standards of the listed banks for lending and the possibility that they may slip in the chase for profits.

First home buyers and or loans above 95% LVR now make up 17% of new loans which doesn’t leave much room for property prices to pullback for a large and growing cohort of Australians to feel under pressure – even if they can still make ends meet. This has implications for the overall economic backdrop in Australia.

Job losses in banking are OK but do not, not, not cut out people from areas that will compromise your risk management or monitoring.

Lending is slow and the Majors are gaining an increasing proportion of this pie.

Households are feeling poorer and remain cautious and are paying down debt at almost double the contracted rate with the higher savings rate persisting.

Households have propped up the Australian banking system by drawing money out of equities such that they now hold half of what they did in equities a few years back and crucially they have put $210 billion on deposit in the past 3 years.

The RBA won’t say it, and this change is probably structural to some extent but when households are less cautious the banking system might need to fill a funding and liquidity gap very quickly as money gets withdrawn from deposits and placed into other asset classes. Still some way off but a material risk to the system.

Scenario, non-MLH, Banks know it and Basel III is driving them to compete even harder for deposits

RMBS markets improved materially but no deals have been done since November 2011, which is kind of an oxymoron I reckon.

Foreign Banks remain marginal players in the Australian banking landscape.

So what?

What does all this mean and how does it impact you and your business.

All of this means that the majors will continue to drive hard both for efficiencies within their own companies but also drive hard to acquire the members and customers of the non-Major ADI’s such as the Credit Unions, Building Societies and Regional banks.

But the strength of these entities, particularly the CUBS and Mutual Banks remains in their business model which fits with the behavioral aspects highlighted in this FSR and the HILDA survey.

Selected quotes and charts from the FSR, full link to the pdf below.

OVERVIEW

The Australian banking system remains in a relatively strong condition. The larger banks are in a better position than a few years ago to cope with the tighter funding conditions given the improvements they have made to their funding, liquidity and capital positions over recent years. Their wholesale funding task is also more manageable, with deposit growth continuing to outpace growth in credit by a wide margin.

The large banks have continued to record robust profits, generating returns on equity that have been broadly in line with long-run averages. However, the slow credit growth environment could constrain the pace of their future profit growth. It would therefore be unhelpful if banks were to chase unrealistic profit expectations by taking on more risk – through lowering credit standards or expanding too quickly into new or unfamiliar markets – or by pursuing cost cutting in a way that weakens their risk management capabilities.

The household saving rate has averaged around 9½ per cent; there has been a shift towards more conservative investment allocations; and many households are choosing to repay their debt more quickly than required.Part of the motivation for a higher saving rate may have been a desire to bolster wealth, given the weakness in some asset markets in recent years. Growth in household income has exceeded growth in debt for the past few years. This has also been helping to underpin households’ debt-servicing capacity. Accordingly, aggregate measures of household financial stress remain low, though mortgage arrears rates are still somewhat higher than a few years ago.

Australian Financial System

Bank lending to households grew by about 6 per cent in annualised terms over the six monthsto January 2012, broadly similar to growth in the previous six months (Graph 2.12). The foreign-owned and smaller Australian-owned banks have continued to see much slower growth in their householdlending than the major banks.

The recent pick-up in banks’ gross bond issuance was in part a response to the large amount of bond maturities over the early part of this year, particularly government-guaranteed bonds: close to $20 billion were due to mature in the first quarter of 2012. Since December 2011, some banks have also continued to repurchase their guaranteed bonds that had around one year or less left before maturity, although at a slower pace than earlier in 2011. Reflecting these repurchases and maturities, banks’ guaranteed wholesale liabilities outstanding have declined to just under $100 billion, down from around $120 billion in August 2011 and $170 billion at their peak in February 2010.

Given the tensions in wholesale funding markets, banks continued to compete actively for deposits, particularly for term deposits and other types of deposits that are likely to attract a more favourable treatment under the Basel III liquidity rules. Spreads between term deposit rates and market rates have increased over the past six months, and are around historically high levels. Growth in deposits has remained strong, at an annualised rate of 12 per cent during the past six months, and continues to exceed credit growth by a wide margin (Graph 2.16). There has been strong growth in both household and business deposits, and across most types of deposit-taking institutions. Reflecting the intense competition for term deposits, their share of bank deposits has increased from 30 per cent to about 45 per cent since mid 2007, at the expense of transaction and savings account deposits. The reduction in the deposit guarantee limit under the Financial Claims Scheme from 1 February has had no discernible effect on the deposit market.

Conditions in residential mortgage-backed securities (RMBS) markets improved during 2011, with issuance for the year as a whole, at $22 billion, the highest since 2007. However, these markets were also affected by the increase in global risk aversion in the second half of 2011, and only two small issues have taken place since the end of November.

After increasing over the past couple of years, the banks’ liquid asset position continued to trend up in recent quarters. The major banks’ holdings of cash and liquid assets increased to around 10 per cent of their total assets in January 2012. Banks’ holdings of internal RMBS also increased slightly over the past six months and now total $150 billion. With the forthcoming Basel III liquidity rules, banks are continuing to assess their required liquid asset holdings and the appropriate mix of these assets.

Foreign Banking Activity in Australia

Branches tend to concentrate on wholesale banking operations because they have more flexibility to access funding globally, including through their parents, and are less constrained by large exposure limits, which helps them meet the demands of large corporate clients. By contrast, subsidiaries tend to be more retail focused, where large exposures are less significant, and their access to local retail depositors means they fund a larger share of their lending through deposits. This difference in business models is evident in the allocation of assets: the bulk of branches’ assets are in commercial loans and securities, while the largest share of subsidiaries’ assets are loans to households (Graph A2).

The largest subsidiary currently has around $47 billion in assets, making it the eighth largest bank in Australia; by comparison, the smallest of the four major banks has about $400 billion in resident assets.

Although the number of foreign-owned banks operating in Australia has more than doubled since the early 1990s, their share of bank assets at the end of 2011, at 12 per cent, was broadly the same.

Household Balance Sheets

Real net worth per household is estimated to have fallen by 6½ per cent over 2011, to be 11½ per cent below its 2007 peak (Graph 3.2). This contrasts with the rapid trend expansion in this series over the decade to 2007 when average annual growth was 6½ per cent. Recently, the weakness in household wealth has been driven by dwelling prices, which were down about 4 per cent on an average nationwide basis over the year to December 2011;

Another sign of the more cautious approach of households is that they have been actively shifting the composition of their financial asset portfolio away from riskier assets like equities and towards deposits. From the beginning of 2008 to September 2011, there were net outflows from households’ directly held equities of nearly $50 billion, while holdings of deposits increased by around $210 billion ($94 billion more than in the previous corresponding period) (Graph 3.3, left panel). The net outflows from equities have come on top of – and were probably in reaction to – declines in equity prices over recent years, especially given that the resulting capital losses coincided with more attractive rates of return available on deposits.

The share of (directly held) equities in household financial assets is now almost half its pre-crisis level, at 9 per cent, while cash and deposits account for 27 per cent, up from 19 per cent in December 2007.

Households have also displayed a less exuberant approach to taking on additional debt in recent years. Growth in household credit has remained at an annual pace of 4½ per cent in the past year, well down on the 14 per cent average growth rate recorded between 2000 and 2010.

Some first home buyers might have also been attracted into the market because lenders resumed offering loans with 95 per cent loan-to-valuation ratios (LVRs) last year. Consistent with this, the share of new owner-occupier housing loans with an LVR above 90 per cent has risen from a trough of 11½ per cent in the June quarter 2010 to 17 per cent in the December quarter 2011.

Total excess repayments were roughly the same as required repayments in the December quarter 2011, up from about 80 per cent in the March quarter (Graph 3.7)

With income growing faster than debt, the ratio of household debt to annual disposable income has, like the interest-servicing ratio, drifted down recently, from 154 per cent in mid 2010 to an estimated 150 per cent in March 2012; however, this is still high by historical standards.

Home Mortgage debt – insights from HILDA

The key insight here feeds from the above where there is proof that all sectors and income brackets of the Australian economy are repaying their debt at a materially accelerated rate.